It’s him again…

SLJ Macro Partners’ Stephen Jen wrote an article recently called “Mind the Falling Bric“, where he makes a warning for EMs in 2012 by comparing their massive credit stimulus in the last few years to the ones in Thailand (circa 1997), Japan (1980s), and the US. Mr. Jen has said recently that the BRL/USD may reach $2.40 if problems in the Eurozone persist and the Fed doesn’t print more money (QE3). His point of view is somewhat similar to the Harvard Professor who said that EMs will see a sudden stop of capital flows in 2012.

Mr. Jen’s point…

A good part of the out-sized growth in many EM economies in recent years has been propelled by a massive credit and liquidity cycle – not too dissimilar to the story of the U.S. in the 2000s and that of Japan in the 1980s. Credit extension in these EM economies in recent years has in turn been driven both by domestic lending as well as foreign capital inflows. The extraordinarily stimulative monetary policies in the U.S. (QE1 and QE2) and Japan have played an important role in helping to fuel these credit cycles. However, we suspect there is a good chance that this massive credit cycle in much of EM may turn this year, potentially violently, due to an economic slowdown in Europe, deleveraging by European banks, a prospective rise in the dollar, and the maturity in the EM credit cycles themselves. Prospective QE3 by the Fed may postpone this turn, but would also make the credit bubble even bigger when it turns. In 2012, the economic and financial risks to the BRIC countries are biased to the downside, in our view. If the scenario we painted above materializes, EM currencies should weaken substantially against the dollar. 


Low-returns in China…

despite the large capital allocation to EM, investors have not been rewarded with good returns. For example, the Shanghai A-Shares were at around 2300 in mid-2001. At end-2011, it closed just under 2300 (!), despite the fact that the nominal GDP of Chin had expanded 10-fold during this period.
Thailand in the 90s…
… credit cycle powered the Thai economy and asset prices before the crash in 1997… Thailand was running large deficits (more than 8% of GDP in 1995 and 1996), experienced deteriorating fiscal deficits, and enjoyed a housing and consumption bubble, as well as exhibiting other familiar traits of a savings-starved and overheated economy (such as taxi drivers speculating on properties).
Massive credit: are Brazil, Russia, India, and Turkey similar to Thailand before the crash?
…the experiences of some other EM economies in the past decade have been very different from that of Thailand, in terms of the evolution of their credit cycles. The chart below shows, compared to an index of 1.0 in 1996, how the credit-to-GDP ratios of Brazil, Russia, India, and Turkey have risen to 1.7, 5.8, 2.1, and 3.0, respectively (Thailand was at 1.6 before the crisis). Nominal GDP in these four countries increased 3- to 5-fold during this period (1996- 2011). So the nominal value of private sector credit expanded massively in all four of these countries.
 

The author also mentions the likely triggers for the credit cycle reversal: slowdown in developed markets, decline of capital flows into EMs, or a more assertive US dollar. And he ends the article by putting a timeline for his predictions (and perhaps his reputation): 
We believe EM currencies may be over-owned and vulnerable to a sharp correction in the first half of 2012. The credit cycle that has helped power many of the EM economies in the past decade looks tired and mature.
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